OSI Systems, Inc. Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2019. The request identifies “2018 Q4,” but the supplied filing is the fiscal 2019 annual report and includes unaudited fourth-quarter results for the quarter ended June 30, 2019.
Business Context
OSI Systems is a vertically integrated designer and manufacturer of specialized electronic systems and components serving homeland security, healthcare, defense, aerospace, medical and industrial markets. Its three reporting segments are Security, Healthcare, and Optoelectronics and Manufacturing.
- Security: 63% of fiscal 2019 consolidated revenue; inspection, detection and turnkey screening systems and services.
- Healthcare: 16% of revenue; patient monitoring and diagnostic cardiology systems.
- Optoelectronics and Manufacturing: 21% of external revenue; optoelectronic components, flex circuits and electronics manufacturing services.
Key Financial Metrics
| Metric | Fiscal 2019 | Fiscal 2018 | Change |
|---|---|---|---|
| Revenue | $1,182.1 million | $1,089.3 million | Up 9% |
| Gross profit | $430.6 million | $391.7 million | Up $38.9 million |
| Gross margin | 36.4% | 36.0% | Up 0.4 percentage points |
| Operating income | $107.8 million | $55.9 million | Up 93% |
| Operating margin | Approximately 9.1% | Approximately 5.1% | Improved |
| Net income | $64.8 million | $(29.1) million | Returned to profitability |
| Diluted EPS | $3.46 | $(1.57) | Improved |
| Cash flow from operations | $119.1 million | $133.1 million | Down $14.0 million |
| Capital expenditures | $27.4 million | $43.2 million | Down $15.8 million |
| Cash and equivalents | $96.3 million | $84.8 million | Up $11.5 million |
| Working capital | $258.9 million | $207.4 million | Up $51.5 million |
| Total debt | $346.6 million | $364.2 million | Down $17.6 million |
Fiscal 2019 product revenue increased to $856.7 million from $732.9 million, while service revenue declined to $325.4 million from $356.4 million. Approximately 58% of revenue came from shipments to customers outside the United States.
Fourth-Quarter Fiscal 2019 Results
| Metric | Quarter ended June 30, 2019 |
|---|---|
| Revenue | $308.4 million |
| Gross profit | $113.0 million |
| Operating income | $27.7 million |
| Net income | $16.7 million |
| Diluted EPS | $0.89 |
Material Changes Versus the Prior Comparable Period
- Security revenue increased 8% to $747.6 million, driven primarily by cargo and vehicle inspection systems and explosive detection systems. Lower checkpoint and trace-detection revenue and reduced Mexico service revenue partially offset growth.
- Healthcare revenue was essentially flat at $188.5 million. Increased patient monitoring and cardiology sales were offset by the de-emphasis of anesthesia products and exit from an underperforming sales channel.
- Optoelectronics and Manufacturing revenue increased 17% to $246.1 million, including $24.5 million from two businesses acquired during calendar 2018.
- Gross margin improved due to economies of scale and favorable product mix.
- Operating expenses declined 4% to $322.8 million. R&D decreased 8%, while SG&A increased 10% to support revenue growth.
- Impairment, restructuring and other charges declined sharply to $3.8 million from $35.0 million. Fiscal 2019 included $4.4 million of restructuring and facility-related costs, $1.3 million of acquisition costs and a $1.9 million net recovery of certain insured legal costs.
- The fiscal 2018 loss was materially affected by $55.3 million of discrete tax expense related to the Tax Cuts and Jobs Act. Fiscal 2019’s effective tax rate was 24.8%, compared with 179.0% in fiscal 2018; excluding discrete items, the rate increased to 28.9% from 26.9%.
- Fiscal 2019 included adoption of ASC 606 using the modified retrospective method. The filing states that adoption increased revenue by $32.9 million and net income by $2.3 million versus results without adoption.
Cash Flow, Debt and Liquidity
- Operating cash flow was $119.1 million. Cash uses included $27.4 million of capital expenditures, $18.3 million for acquisitions, $26.7 million of net debt repayment and $35.0 million for share repurchases and taxes related to equity-award settlements.
- The revolving credit facility was increased to $535 million and extended to April 2024. At June 30, 2019, borrowings were $88.0 million, letters of credit under the facility were $55.9 million and stated borrowing availability was $391.1 million.
- The company had $287.5 million principal amount of 1.25% convertible senior notes due September 2022. The notes were not convertible at fiscal year-end under the applicable stock-price condition.
- Approximately 87% of cash was held by foreign subsidiaries, subject to repatriation tax considerations.
- Management stated that cash, available credit facilities and operating cash flow should be sufficient for operational needs over the next 12 months and the foreseeable future, subject to acquisitions, capital expenditures, litigation, repurchases, R&D spending, cash generation and covenant compliance.
Backlog, Outlook and Management Commentary
- Consolidated backlog was approximately $911 million at June 30, 2019, down from $976 million at June 30, 2018. Approximately $287 million was not reasonably expected to be fulfilled in fiscal 2020.
- The filing does not provide formal fiscal 2020 revenue, earnings or margin guidance.
- Management highlighted opportunities from global security demand, EU hold-baggage screening requirements and the company’s ECAC Standard 3-compliant real-time tomography product.
- Management also cited uncertainty from U.S. and international government budgets, sequestration, Brexit, tariffs and sanctions, foreign exchange movements, healthcare spending and regulatory developments.
- The company completed several acquisitions during fiscal 2019, including an optoelectronics solutions business acquired for $17.5 million plus potential contingent consideration and a Security services acquisition for approximately $0.8 million plus potential contingent consideration.
Risks, Contingencies and Unusual Items
- Remaining shareholder securities and derivative litigation related to a 2017 short-seller report was unresolved. The company considers the claims without merit, but stated that outcomes and potential losses could not be predicted or estimated.
- The DOJ and SEC closed their FCPA inquiries in May and June 2019 without action. Separate SEC and DOJ investigations into trading in company securities remained pending, and potential actions or penalties were not estimable.
- The company continues to investigate historical soil and groundwater contamination beneath its Hawthorne, California facility. No environmental loss contingency was accrued because management did not consider an adverse outcome probable and reasonably estimable.
- Government contracts may be terminated, renegotiated or delayed, and direct U.S. Government sales were approximately $173 million in fiscal 2019.
- The company faces medical-device regulation, cybersecurity and data-privacy requirements, including FDA, EU MDR, GDPR and HIPAA-related obligations.
- Competition, contract acceptance delays, customer concentration at major institutions, international operations, tariffs, currency movements, single-source suppliers, inventory obsolescence and acquisition integration may affect results.
- The company’s credit facility contains financial and operating covenants. Management reported compliance at June 30, 2019.
Important Facts for Investors to Verify
- Confirm that the applicable period is the fiscal year ended June 30, 2019 rather than a fiscal 2018 fourth-quarter filing.
- Review the sustainability of the 2019 operating-margin improvement after unusually low impairment, restructuring and legal-related charges.
- Assess the quality and timing of the $911 million backlog, including the $287 million not expected to be fulfilled in fiscal 2020.
- Evaluate liquidity in light of the $287.5 million convertible-note maturity in 2022, variable-rate revolver borrowings and letters of credit.
- Monitor working-capital trends, accounts receivable growth, inventory valuation and the $273.7 million inventory balance identified as a critical audit matter.
- Track the pending securities-trading investigations, shareholder litigation and Hawthorne environmental matter for potential financial or reputational effects.
- Assess the impact of ASC 606 adoption on revenue timing and contract assets, including $19.3 million of unbilled revenue at June 30, 2019.
- Consider foreign-currency exposure: management estimated that a 10% appreciation or depreciation of the U.S. dollar would change fiscal 2019 operating income by approximately $8.8 million in the opposite direction.